don't understand why business schools don't teach the Warren Buffett model
of investing. Or the Ben
Graham model. Or the Peter Lynch model. Or the Martin Whitman model. (I
could go on.) In English, you study great writers; in physics and biology,
you study great scientists; in philosophy and math, you study great
thinkers; but in most business school investment classes, you study modern
finance theory, which is grounded in one basic premise--that markets are
efficient because investors are always rational. It's just one point of
view. A good English professor couldn't get away with teaching Melville as
the backbone of English literature. How is it that business schools get
away with teaching modern finance theory as the backbone of investing?
Especially given that it's only a theory that, as far as I know, hasn't
made many investors particularly rich.
Hathaway, under the stewardship of Buffett and vice chairman Charlie
Munger, has made thousands of people rich over the past 30-odd years. And
it has done so with integrity and a system of principles that is every bit
as rigorous, if not more so, as anything modern finance theory can dish up.
On Monday, 11,000 Berkshire
shareholders showed up at Aksarben Stadium in Omaha to hear Buffett and
Munger talk about this set of principles. Together these principles form a
model for investing to which any well-informed business-school student
should be exposed--if not for the sake of the principles themselves, then
at least to generate the kind of healthy debate that's common in other
Whereas modern finance
theory is built around the price behavior of stocks, the Buffett model is
centered around buying businesses as if one were going to operate them.
It's like the process of buying a house. You wouldn't buy a house on a tip
from a friend or sight unseen from a description in a newspaper. And you
surely wouldn't consider the volatility of the house's price in your
consideration of risk. Indeed, regularly updated price quotes aren't
available in the real estate market, because property doesn't trade the way
common stocks do. Instead, you'd study the fundamentals--the neighborhood,
comparable home sales, the condition of the house, and how much you think
you could rent it for--to get an idea of its intrinsic value.
The same basic idea applies
to buying a business that you'd operate yourself or to being a passive
investor in the common stock of a company. Who cares about the price
history of the stock? What bearing does it have on how the company conducts
business? What's important is whether you can purchase at a reasonable price
a business that generates good returns on capital (Buffett likes returns on
equity in the neighborhood of 15% or better) without a lot of debt (which
makes returns on capital less dependable). In the best of all worlds, the
company will have a competitive advantage that allows it to sustain its
above-average ROE for years, so you can hang on to it for a long time--just
as you would live in your house--and reap the power of compounding.
Buffett further advocates
investing in businesses that are easy to understand--Munger calls it
"clearing one-foot hurdles"--so you can come up with more
reliable estimates of their long-term economics. Coca-Cola's
basic business is pretty staid, for example. Unit case sales and ROE
determine the company's future earnings. Companies like Microsoft
as they are--require clearing much higher hurdles of understanding because
their business models are so dependent on the rapidly evolving world of
high tech. Today it's a matter of selling the most word-processing
programs; tomorrow it's the Internet presence; after that, who knows. For
Coke, the challenge is always to sell more cases of beverage.
Buying a business or a stock
just because it's cheap is a surefire way to lose money, according to the
Buffett model. You get what you pay for. But if you're evaluating
investments as businesses to begin with, you probably wouldn't make this
mistake, because you'd recognize that a good business is worth buying at a
Finally, if you follow the
Buffett model, you don't trade your investments just because our liquid
stock markets invite you to do so. Activity for the sake of activity begets
high transaction costs, high tax bills, and poor investment decisions
("if I make a mistake I can sell it in a minute"). Less is more.
I'm not trying to pick a
fight with modern finance theory enthusiasts. I just find it unsettling
that basic business-school curricula don't even consider models other than
modern finance theory, even though those models are in the marketplace
proving themselves every day.